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The Economy – Unusually Uncertain Isn’t Exactly What We Had in Mind

Signature Update July 22, 2010 Edition, Volume IV

Wednesday afternoon, Ben Bernanke began two days of semi-annual reporting of monetary policy before Congress.  While the Fed Chairman will certainly use the forum as an opportunity to outline the Fed’s economic expectations for the coming quarters, maybe this time members of congress will actually ask Bernanke about monetary policy issues rather than use him as an expert witness in favor of their favorite partisan points.

The biggest question investors had awaiting Bernanke’s comments was “In an economy in which inflation is below targets and unemployment is high, why isn’t the Fed doing what it can to stimulate economic activity?”  Helicopter Ben answered it and then some; he’s waiting for the right timing and market conditions, and oh… by the way… these are unusually uncertain times.  The market loved that comment to the tune of an over 100 point drop on the DOW and we’re not sure what Bernanke meant.  Anyone paying attention for the last 15 years might have noticed that uncertainty has been a market constant – whether for good or ill. 

The Fed has monetary policy tools at its disposal, but with interest rates essentially at 0%, there’s little the Fed can do with rates.  However, the Fed can reinstitute its program to purchase US treasury bonds and mortgage backed securities.  For now, Bernanke believes that the benefits of employing more of its policy tools, including purchasing these instruments, is outweighed by the cost.   The Fed may be holding onto these weapons in the event that the economy needs major assistance to avoid a double dip.

The market turned from a 125+ point loss to a gain of over 75 points Tuesday July 19th on rumors the Fed may stop paying interest (low that it may be) on bank deposits held at the Fed and then lost ground on Wednesday as a result of top-line sales concerns.

Tuesday’s rumor turned out to be unfounded conjecture, but the market’s willingness to react to such reports reveals the need for concrete action from policy makers to get bank lending back up to levels supportive of economic growth.  Even though the earnings banks can receive through Fed balances are minute, they’re also certain, and at current levels of risk and reward offer a more attractive picture for bankers.  If banks are no longer able to receive gains on Fed deposits, they’ll need to look elsewhere for yield, which should cause them to loosen up lending and seek other investment opportunities.

Likewise, the market decline surrounding Bernanke’s comments Wednesday represented reaction to little more than anticipation at what Bernanke might say next.  As President  

Obama promised no more Wall Street bailouts during his signing of the recently passed financial regulatory reform bill, the markets waited for Bernanke.  As important corporate earnings reports were being digested by investors and analysts the market waited for Bernanke.  When Bernanke spoke the market stopped waiting and gave up ground in the face of two more important events: banking reform and the reporting of corporate profits in excess of expectations.

Thursday July 22nd’s rally of some 200 points on the DOW amounts to the market’s wake-up to what was glossed over the day before – companies are making money and employees are slowly returning to the work force; exactly what we might expect in the 3rd and 4th quarters following an extended economic downturn. 

 

 

 

 

 

Signature Update is offered by Richard Haskell, Managing Director of Signature Wealth Management  and CEO of Signature Management, LLC


Disclosure: no positions